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EU High Court Issues Death Knell to Popular Dutch Tax Regime

Trust Bloomberg Tax's Premier International Tax offering for the news and guidance to navigate the complex tax treaty networks and business regulations.

By Linda A. Thompson

Europe’s highest court has dealt an irrevocable blow to a tax regime that allowed
thousands of Dutch companies to deduct intragroup interest expenses from their taxable
profits.

Some of the Dutch tax regime’s provisions break European Union rules on freedom of
establishment, the Court of Justice of the European Union said in the Feb. 22 decision
on two conjoined cases (
C-398/16 and C-399/16).

The decision against the Netherlands—which tax practitioners had anticipated—means
higher tax bills and major administrative headaches for the thousands of Dutch companies
that have formed tax consolidation groups. It will also require a serious rewrite
of some the country’s corporate tax provisions.

“Companies are being saddled with a great deal of work and a great deal of uncertainty
because they will have to identify all sorts of intragroup transactions and money
flows that had never been an issue in the past,” Alexander Bosman, a tax adviser at
the Loyens & Loeff law firm, told Bloomberg Tax.

A bill introducing measures aimed at stemming the future budgetary impact of the ruling
will be sent to the House of Representatives in the second quarter of 2018, according
to a
Feb. 22 letter from State Secretary for Finance Menno Snel. Those measures, first announced in October
2017, will retroactively activate rules limiting the deductibility of interest payments
on transactions between entities in a tax consolidation group that until now didn’t
apply.

The Regime

The Dutch tax consolidation regime treats a group of related companies as a single
entity for corporate income tax purposes. Such tax consolidation groups offer considerable
tax benefits, particularly when companies with heavy debts partner up with a related
profit-making entity. Under Dutch law, only resident companies can form a tax consolidation
group.

Used by companies large and small across all industries, by purely domestic companies
and those with extensive international operations, the Dutch tax consolidation regime
is a popular one. According to figures from the Dutch Finance Ministry, 300,000 companies
were part of a tax consolidation group in 2015—about 40 percent of the 745,000 entities
that filed corporate tax returns that year.

Interest Deductions

The crux of the decision is article 10a of the country’s corporate income tax code,
an interest limitation rule under which companies with a parent or subsidiary entity
in another EU member state were previously denied interest deductions. Those companies,
like the taxpayers at the center of the cases, will be able to deduct certain interest
expenses from their taxable profits after all.

The government said it “regrets” that the court ruled the Dutch scheme regarding the
interest deduction conflicts with EU law.

But in the court’s view, even though the provision may be formulated neutrally, cross-border
companies are at a disadvantage compared to resident companies that can form tax consolidation
groups, said Jasper Korving, senior tax manager at Deloitte Netherlands.

“You cannot say that 10a always applies to both cross-border and domestic situations,
but because resident companies can form a fiscal unity they aren’t confronted with
this interest deduction limitation,” he said, adding that the court viewed this as
an additional advantage stemming from the fiscal unity that didn’t have anything to
do with the “essence of the regime.”

About 11,000 companies will be able to invoke the decision to deduct interest paid
in the past and reclaim overpaid taxes in the financial years between 2012 and 2017.
If all those companies do so, the country’s tax coffers could be depleted by 400 million
euros ($493 million), the government said in a
letter sent to lawmakers in 2017.

Tax Battles to Come?

“In principle, you might have to go back tens of years to examine whether certain
loans or transactions fall under the scope of” the 10a interest deduction limitation,
Bosman said Feb. 22, adding that this would be an “enormously laborious” task.

Noting that the 10a interest limitation deduction also included exceptions as well
as “room for interpretation,” he warned that the decision might result in more disputes
with the Dutch tax administration and potential double taxation for corporate taxpayers.

“And it could naturally lead to higher tax debts for companies than under the current
rules because the consolidation aspect is being let go of for certain money flows,”
he said.

Concessions Coming

“The cabinet regrets that the unique element of the Dutch fiscal unity, the consolidation
notion is coming to an end with” Snel said in the Feb. 22 letter following the decision.
Any future intragroup arrangement, he added, likely wouldn’t include “this unique
consolidation element.”

Korving noted that the letter seemed to signal the government’s plan to “kill off”
the tax consolidation regime, but he also saw some positives. The letter “seems to
say that if really good arguments are brought forward, there will still be the possibility
to maintain the tax consolidation regime in one way or another,” he said.

The Dutch cabinet is expected to replace the tax consolidation regime with a new group
contribution system, but both lawmakers and practitioners said that this new system
just wouldn’t be the same.

A group relief or group contribution system similar to those existing in other EU
countries will be markedly different from the current tax consolidation regime, Bosman
said.

“The Dutch fiscal unity is a true tax consolidation system,” Bosman said, pointing
out that it makes the Netherlands unique in the EU. A tax consolidation system makes
it possible for tax-neutral reorganizations in which activities can be transferred
from one group entity to another, or assets and liabilities can be merged without
triggering a tax, he said.

While a tax consolidation regime allows companies to only file one tax return, a group
contribution system would require each standalone entity to file its own return. The
“group approach” that allows the profits of one entity to be offset from the losses
of another is only applied later, Bosman said.

“What we now have is a very broad arrangement, while a group contribution system would
represent a much more limited concession,” he said.

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